[FAQs] Method of Accounting | GST | Ind AS under Tax Audit – Ensuring Effective Tax Audit Compliance

Section 145A stipulates the inclusion of taxes, cess, etc., in the value of sales, purchases, and inventory for the purposes of calculating income under the ‘Profits and Gains from Business or Profession’ category. The application of this section specifically to ‘sales turnover’ for Sections 44AA, 44AB, 44AD, and 44ADA remains a contentious issue between taxpayers and the revenue authorities.

For assessees who participate in the GST Composition Scheme, GST is not charged to customers but is accounted for as an indirect expense in the profit and loss statement. Therefore, GST does not contribute to the gross turnover of such assessees. For other assessees who do record GST separately in their accounts after charging it to customers, it is ambiguous whether GST should be counted in the turnover solely for calculating taxable income (as per Section 145A) or for all references to ‘turnover.’

Pending clarification from the CBDT on this issue, it is prudent to exclude GST from the gross turnover or receipts calculation for several reasons:

• Section 145A explicitly states its purpose is for determining income under the ‘Profits and Gains of Business or Profession’ head, suggesting it does not apply to other calculations involving turnover.
• According to the ICAI’s Guidance Note on Tax Audit, GST collected and credited to separate current liability accounts (such as Output CGST, Output IGST, or Output SGST) and corresponding payments to the authorities, should not be included in the turnover presented in the profit and loss account.
• Including GST in turnover calculations could lead to a cascading effect, where presumptive income calculations unjustly include GST, which is not considered income for the assessee.

These guidelines suggest that excluding GST from turnover calculations avoids complications until an official directive is issued.

Indirect taxes, as referred to in Clause 4 of Form No. 3CD, include taxes such as excise duty, service tax, sales tax, GST, and customs duty. To accurately verify which indirect taxes apply to an assessee, a tax auditor should first request a detailed list of all relevant indirect taxes from the assessee. The auditor should then obtain the registration certificates for these taxes, ensuring each certificate contains the proper registration numbers as per the applicable tax laws. It is critical for the auditor to verify the correctness of these registrations and to report any discrepancies, such as a missing registration where required, in the audit findings.

When an assessee possesses multiple GSTINs (Goods and Services Tax Identification Numbers), each corresponding to different states, Clause 4 of Form No. 3CD requires that all GSTINs be reported. According to Para 20.4 of the 2022 Guidance Notes, if an assessee holds multiple registration numbers under any indirect tax, the tax auditor must review each one. The amendment in the 2023 Guidance Notes further specifies that these numbers should not only be examined but also duly reported.

The 2023 Guidance Notes remove the previously included sentence from Para 20.4, which posed the question of whether the assessee is obligated to pay any mentioned indirect taxes. Consequently, the responsibility of the tax auditor no longer extends to resolving the complex issue of the assessee’s liability under these taxes.

Clause (4), found in Part A of Form No. 3CD, typically compels the auditor to report factual details concerning the assessee. Therefore, the auditor’s role is specifically to document the registration numbers as provided by the assessee, without needing to ascertain the client’s tax liabilities under the indirect tax statutes.

As per the Implementation Guide by ICAI dated August 22, 2018, it is essential to include the GST registration number in Form 3CD even if the assessee’s liability to pay GST arises exclusively under the reverse charge mechanism. The form should clearly indicate that the liability pertains solely to the reverse charge mechanism to ensure transparency and compliance.

When an assessee shifts from a cash basis to a mercantile basis of accounting, specific disclosures are required in the e-filing utility for Form 3CD:

• In Clause 13(a), the tax auditor must select “mercantile system.”
• In Clause 13(b) (regarding any change in the method of accounting), the auditor should select “Yes.”
• Clause 13(c) requires the auditor to detail the change in the accounting method and its impact on the profit or loss. The auditor should prepare a worksheet to estimate the hypothetical net profit or loss if the assessee had maintained the cash basis. This worksheet aids in completing Clause 13(c), illustrating the financial implications of the accounting method change:

The assessee is permitted to use different accounting methods for different income sources. This principle is supported by the Allahabad High Court in J.K. Bankers v. CIT [1974] 94 ITR 107, which confirms that an assessee may employ one accounting method for certain income sources and a different one for others. Similarly, the Bombay High Court in CIT vs Smt. Vimla D. Sonwane [1994] 212 ITR 489 upheld the freedom to adopt varying accounting methods depending on the circumstances. The Income Tax Department cannot insist that the assessee use the mercantile system exclusively.

Furthermore, Para 25.1 of the ICAI’s Guidance Note on tax audit affirms that an assessee may choose the cash system for one business and the mercantile system for another. Consistency is required once a method is selected.

While Form 3CD does not facilitate the reporting of different accounting methods for various income sources, it is recommended that the primary method used for the main source of income be declared in Form 3CD. Any alternative methods used for other business endeavors should be detailed in the notes accompanying the form.

The term “Method of Accounting” encompasses the fundamental rules and guidelines that businesses use to maintain their financial records and prepare their financial statements. There are two primary methods of accounting: the Cash Basis and the Accrual Basis. However, Accounting Standards or Ind AS mandate the use of the accrual basis for accounting. These standards are crucial for financial reporting and serve as the primary source of generally accepted accounting principles (GAAP).

It is important to distinguish between the method of accounting and GAAP. The method of accounting refers to the foundational approach—either cash or accrual—used to record transactions. GAAP, on the other hand, outlines the principles and procedures for recognizing financial transactions within the accrual basis framework. Transitioning from Accounting Standards to Ind AS does not entail a change in the accounting method; therefore, such a switch should not be considered a change in the method of accounting.

Clause 37.2 of the 2022 General Notice required tax auditors to verify that a provision for gratuity was made according to the trust deed. The 2023 amendment modifies Para 37.2, now mandating that the tax auditor must verify the provision against the trust deed, its governing rules and regulations, and stipulations from the PCIT/CIT Approval Order.

If a liability increase results from changes in actuarial assumptions, this additional expense is recognized in Other Comprehensive Income (OCI) as per Ind AS 19 – Employee Benefits. Nonetheless, unless such gratuity provision is paid, it is not deductible under section 40A(7). Clause 21(e) imposes a duty on auditors to report all such provisions.

Therefore, if a gratuity provision increases due to changes in actuarial assumptions like the discount or mortality rate, the additional expenses recognized in OCI should not be deducted while calculating taxable business income. Any increase in the gratuity provision attributed to these changes should be reported as disallowable under Clause 21(e).

Under Ind AS, the processing fees paid to banks or financial institutions for borrowings must be amortized over the loan’s tenure. This means that the borrowing cost recognized in a year consists of the actual interest paid or payable to the bank plus the amortized portion of the processing fees.

For tax purposes, deductions for such borrowing costs are governed by Section 43B of the Income-tax Act, which mandates that deductions for interest and processing fees are allowed on a payment basis. Therefore, if the processing fee is paid to the bank, the entire fee is deductible in the year it is paid, regardless of how it is recognized in the financial statements.

The Income-tax Act allows for the deduction of the total amount of interest or processing fees paid to the bank during the year, irrespective of the recorded borrowing cost. These deductions should be disclosed under Clause 26.

Clause 27(a) is applicable to all assesses registered under CENVAT/Central Excise. Although Form 3CD traditionally references CENVAT, the e-filing utility has been updated to include CENVAT/ITC (Input Tax Credit). Thus, all relevant details pertaining to GST or Central Excise should be included in Form 3CD as required.

Under Ind AS 101 – First Time Adoption of Indian Accounting Standards, when transitioning from AS to Ind AS, it is required to recalculate and present opening balances and comparative figures in accordance with Ind AS.

The Income-tax Act does not specify methods for calculating gross profit, turnover, or ratios for disclosure in Form 3CD. Therefore, these disclosures must align with the financial statements prepared under either AS or Ind AS. Since the entity must present comparative figures in its Ind AS financial statements, this same information should be utilized for the relevant disclosures in Form 3CD.

Clause 44 of Form 3CD requires auditors to provide a detailed account of total expenditures incurred during the year. Specifically, auditors must present a breakdown of expenditures involving entities registered under GST as well as those relating to entities that are not registered under GST.

It should be noted that the CBDT[1] has deferred the reporting requirements under Clause 30C and Clause 44 of the tax audit report until 31st March 2022.

Consequently, the required information for these clauses should be included in audit reports submitted on or after 31st March 2022.

Clause 44 of Form 3CD requires a detailed reporting of total expenditures incurred during the financial year, formatted as follows:

• Total expenditure incurred during the year.
• Expenditure concerning entities registered under GST, subdivided into:

1. 1. Expenditure related to goods or services exempt from GST.
   2. Expenditure related to entities under the composition scheme.
   3. Expenditure related to other registered entities.
   4. Total payments made to registered entities.

• Expenditure concerning entities not registered under GST.

The Guidance Note issued by ICAI clarifies several aspects for reporting under this clause:

• Scope of Expenditure Reporting – While the table heading suggests a breakdown of “total expenditure,” this implies inclusion of all purchase-related expenses, without requiring a head-wise or nature-wise detailed reporting.
• Non-Expenditure Items – Items such as depreciation under Section 32 and bad debt deductions under Section 36(1)(vii), which are not considered expenses, should not be included in this reporting.
• Non-Supply Transactions – Transactions listed in Schedule III of the CGST Act, 2017, which are neither goods nor services supplies, do not need to be reported here. For example, employee salaries are excluded as they are considered services by an employee to the employer.
• Expense Allowability – The registration status of the payee under GST does not influence the deductibility of an expense as long as it is incurred wholly and exclusively for the business.
• Capital Expenditure Reporting – The term “expenditure” in this clause also encompasses capital expenditures, which should be reported to facilitate reconciliation.
• Branch Expenses – Reports should encompass the entity as a whole or specific branches, with expenditures consolidated under various GST registrations as applicable.

These guidelines aim to ensure comprehensive and accurate reporting under Clause 44, aligning with regulatory requirements and aiding in the financial transparency of the assessee.

According to Para 82.3 of the 2023 Guidance Note (GN), Clause 44 of Form 3CD requires auditors to report expenditures in two specific categories: (a) Expenditure concerning entities registered under GST, reported in columns 3-6. (b) Expenditure relating to entities not registered under GST, reported in column 7. These reports should only include expenses that qualify as a ‘supply’ under section 7 of the CGST Act, 2017.

Further, the new Para 82.4 of the 2023 GN stipulates that tax auditors are required to keep a reconciliation working paper. This document should reconcile the total expenditure as per the Profit & Loss (P&L) account with the expenditures reported in Clause 44 and it is reported in the following manner:

* Details of all deductions & additions must be maintained for each sub-entity (GSTIN-wise) of the legal entity.

New Paragraph 82.16 of the 2023 Guidance Note (GN) offers the following clarifications:

• Auditors need to distinguish between the ‘current status’ of a supplier’s GST registration and its status at the time of the transaction with the assessee.
• It’s possible for a supplier’s registration to be canceled retroactively, affecting dates before the transaction with the assessee occurred.
• Changes to a supplier’s registration status after the balance sheet date do not change the nature of the recorded expenses as those incurred with registered suppliers.
• Tax auditors have the discretion to review the supplier’s status up to a specific cut-off date or choose not to extend their review. Regardless of the approach, auditors should disclose any known cancellations and explain how such cancellations have been considered in their audit disclosures.

Paragraph 82.18 of the GN 2023 further clarifies that entities with multiple GST registrations may engage in inter-branch supplies, which should be eliminated in the consolidated financial statements. Auditors should ensure that proper reconciliation of these transactions is documented.